The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney

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A Discussion of the Current Market Environment
Jim Lange, CPA/Attorney
Special Guest: Charlie Smith, Principal and Chief Investment Officer of Fort Pitt Capital Group
Episode 16

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  1. Introduction of Special Guest, Charlie Smith
  2. You're Not Getting Paid to Sit on Cash
  3. The Role of the Regulators
  4. Is the Recession Over?
  5. Rebuilding of Personal Savings
  6. Increase in Bank Lending
  7. Information Resources for Investors

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at Now get ready to talk smart money.

1. Introduction of Special Guest, Charlie Smith

Beth Bershok: We are talking smart money, and thank you so much for joining us tonight. I’m Beth Bershok, along with Jim Lange, CPA, attorney, best selling author of two editions of the book Retire Secure Pay Taxes Later. And our guest tonight, Charlie Smith, Principal and Chief Investment Officer of Fort Pitt Capital Group, and we are going to be doing a lot of talking about the current market environment tonight. First of all, Charlie, I have to mention that you were in The Post Gazette this morning, quoted in, if you went to the business section, the very front page had a big article called In An Uncertain Economy What Could be Safer Than a Pile of Money? And go about midway through the article, and Charlie is quoted in there. And you actually say that smart money will stay invested in stocks, can you explain that?

2. You're Not Getting Paid to Sit on Cash

Charlie Smith: Thanks for having me, I appreciate the chance to come on with you. Yeah, I didn’t even see that article today, but our basic philosophy at Fort Pitt Capital Group is, over time there is such a thing as the equity premium, that is, you’re going to be paid to be an investor in businesses and you know the rage right now, particularly after the debacle in the financial markets last year, is to sit on a pile of cash as depicted in the article. And you know the Fed and Treasurer are doing everything they can right now to try to get people out of cash investments. They push the rates on cash down to zero. Most money market funds are paying almost zero. So it really behooves investors to think about the returns that are available in a cash investment, essentially zero, and try to move out the risk spectrum, move out the maturity spectrum a little bit to take a little bit of risk, because you’re not getting paid to sit on cash.

Beth Bershok: I do know people who not only sat on cash, but essentially cashed out.

Charlie Smith: When that’s the big question?

Beth Bershok: In the spring. So if you did that, you’re probably missing some of the recovery?

Charlie Smith: Well, the issue is, when you make a decision to either go all in, or all out, depending on your age, I mean if you’re 95 years old and you’re essentially coming to the end of your investing life, that’s one thing. But if you’re a younger person, anywhere between 25 and 60, say, to go all out, you’re going to have to make another good decision at some point to get back in. And we find it hard enough to make one good decision, so the problem compounds itself. So the issue for us is. not all out, or all in, it’s building a portfolio of reasonably well run businesses, that we pay a reasonable price for. So we’re not necessarily worried about making the all in or all out call, it’s owning businesses that we know we have done the work on and understand and have paid a reasonable price for.

Beth Bershok: Now, essentially, if you’re looking at the past months, March was the bottom, am I right? Were we at the bottom in March?

Jim Lange: Yes, that’s right.

Beth Bershok: And do you guys think, do, Jim and Charlie, do you both think that was the bottom, or do you think there’s still a bottom to come?

Jim Lange: That’s a Charlie question, not a Jim question.

Charlie Smith: We had our investment policy committee meeting on Tuesday morning, and one of the things I said, we are not going back to 666 on the S&P, that was where we closed on March 6th. I would put the odds on some sort of a cataclysmic event in the financial system that could drive us back there at less than 1 in 5, and those are pretty low odds. And, primarily, because as I mentioned in the PG article today, the policy makers are continuing to do absolutely everything they can to support the financial system, including the Fed, basically printing $800 billion to a trillion dollars, the Treasury, borrowing hundreds and hundreds of billions of dollars to put into the financial system to support it. So when you’ve got the power of the printing press working against an apocalyptic collapse like some people are still expecting, I think the odds on that are pretty low.

Jim Lange: Is it fair to say, that if you do have your money in cash and CDs, and money markets, and low yield fixed income type investments, that people think that that is safe, but in reality, that is not a protection against taxes and inflation? And is it fair to say that the risk, if you will, even though it’s more predictable that inflation could, actually, be a bigger danger than losing money in the markets?

Charlie Smith: Yes, I think if you look at the historic levels of annualized return from equities, long term corporate bonds, long term treasuries, and short term cash investments, you will see that over an extended time period, cash investments earn you no real return. And then, when you put a tax rate on those cash investments, you’re ending up behind inflation. So the only real way to protect the value of your assets over time, is to own assets which compound at some rate well above the risk free rate, and you want to own pieces of businesses. You know there’s a reason that the list of people on the Forbes 400 doesn’t include people who own bonds, or money market funds. It’s because the way that you build wealth over time is to accumulate a little bit of capital, add your label and management expertise, and compound it. You know the value is added in the human interaction and the human input.

Jim Lange: Well, some of the comments that I get from some of my clients in their, let’s say, 60s and 70s, are well, yes, I understand. And you show me these graphs that show that over the long period, that the market returns much higher than a cash or even a treasury bond or a CD, but gee, Jim, I don’t know how many years I have left, can I afford to take the risk of the market going down substantially, and I don’t have enough years to invest, and on top of that, I’m using my current investments as the source of my lifestyle?

Charlie Smith: Sure. We obviously have many clients who are in exactly that position and our response to those people is, you figure out what your investment horizon is, even if you’re 65 and just about to retire, the actuaries will tell you that you’re going to live another 23-25 years. So you may retire, but you can’t afford to retire your money. What we do for people in that position is say, what are your cash flow needs, how much cash do you need from the portfolio every year? Let’s set aside three to five years worth of your cash flow need in cash today, ready cash, so that we can take that segment of the portfolio and put it aside and not have to worry about it so that if we do get a five year downturn, or maybe even a ten year downturn, as we’ve seen since 1999 in the S&P 500. You know the S&P has gone nowhere for ten years, essentially. You get an environment like that at least the first 5 years of that downturn, you’re not going to have to be taking money out when the market is potentially at a bottom.

Beth Bershok: Now, Charlie, you just said that have X amount of ready cash, X amount of months, should you be doing that anyway, or you just talking about this particular situation?

Charlie Smith: It depends on two things. It depends on your risk tolerance. We have some clients with us who are 85 years old, and are withdrawing 4-5% of the portfolio, well maybe 4% of their portfolio a year, and they have 70-80% of their portfolio in stocks because they recognize that they’ve got a time horizon that may be beyond 6, 7, 8 years, and you know, historically, the period we’ve seen in the last 10 years is very unusual. And with the ability to ride through the slings and arrows of an up and down market, you’re going to earn more money over time.

Jim Lange: And for that person, let’s say for somebody in their 80s, for example, and I think we’ve all heard of, well, you take your age and you subtract it from 100, and that’s how much bonds and that’s how much stocks, which, obviously, I think doesn’t have very much merit. But I would say that, for a lot of those people, and particularly that generation, they don’t tend to be great spenders, so sometimes, 4% withdrawal rate of their portfolio is well above what they are currently spending.

Charlie Smith: Exactly.

Jim Lange: And in that case, ultimately, you’re not really investing for somebody in their mid 80s, you’re investing for somebody in their, maybe, 40s, or however old their children are.

Charlie Smith: Exactly, you’re investing in the next generation, and their time horizon is 40-50-60 years. If you think in terms of a 40 year old, maybe needing the funds when they’re 70 or 75, you have at least a 35 year horizon from there. So, yes, people with substantial assets, and can see down the road the ability to pass those assets on, the time horizon on those monies is inherited by the next generation, so it’s longer.

Jim Lange: And I also take it that you take into account somebody’s situation, so, for example, let’s say somebody has a pension, or they are a teacher, and they’re getting a guaranteed income from the state, and let’s say social security. Do you say, well, you can kind of look at that as the guaranteed, or the fixed income portion of the portfolio, and therefore, even if normally, what might be appropriate as a 50% stock, 50% bond, but if they have a pension, or social security, that you could have significantly more…

Charlie Smith: Equity exposure.

Jim Lange: Right.

Charlie Smith: Yeah, exactly. You can take whatever pension benefit or social security benefit that you’re going to be receiving, and plug it in as part of the cash flow portion, or the fixed income portion of your portfolio. We have a lot of customers who are entrepreneurs and have, sort of, funded their own retirement, so they’re living only off their investments plus social security. They don’t necessarily have a corporate pension, but that’s certainly an ingredient in deciding what fraction of your portfolio should be in stocks. If you can see a substantial social security payment, and a pension payment, you probably can afford to take a little more of your portfolio in stocks.

Jim Lange : Okay, in general, you do seem to be a believer in free markets and capitalism. Is that a fair statement?

Charlie Smith: Wow, that’s about as sickly as you can say it. Yeah, I mean, our system has a few warts on it, but yeah, I’d have to say that individual initiative and the ability to know… I value freedom above equality, I guess is the best way to put it. I think each value is an important value, but in the end, society is better off if you put freedom slightly ahead of equality of outcome.

3. The Role of the Regulators

Jim Lange: Alright, well, some people would say that the recent problems we’ve had, let’s say, over the last year, is because of a lack of oversight by our government and our institutions. I would have two questions, one, do you agree that that is ultimately one of the problems? And two, if so, or even if not, do you see any changes in the oversight that would give you greater confidence that something like we just experienced will not happen again, or at least, a vastly reduced chance of happening again?

Charlie Smith: First of all, I do believe that people say that when a plane crashes, it’s usually a combination of events. Most of the investigators, in the end, can’t point to one single factor that causes an airplane to crash. If you want to carry that analogy over to the economy, I think we had a set of public policies with regard to mortgage finance, in particular, that caused us all to lose track of the fundamental value of housing. We tended to, literally, over value housing and, you know when we were pushing to get 66-68% of our citizens in their own homes, I think we were sort of violating a cardinal rule that you get beyond a certain percentage of the population, and they’re just not set up to be homeowners. And when we instilled a set of public policies that were trying to reach this end, we lost track of some of the economic fundamentals. So it was a combination of the ability of Wall Street promoters to sell mortgage investments that really didn’t have a whole lot of fundamental value with them, combined with a public policy effort to get more and more people into houses that got us way off track. So, yes, there were regulatory issues. There was a lack of regulatory oversight, particularly in the housing market, and the growth and the ambiguity of Fannie Mae and Freddie Mac and government financing for housing that I think drove us over the edge. Have I seen any moves or positive policy responses with regard to a new regulatory regime? Not yet.

Beth Bershok: And we should point out, there are proposals currently in front of congress, some quite extensive really, to overhaul the whole system.

Charlie Smith: And particularly to give the Fed more responsibility.

Beth Bershok: And it seems, Charlie, like the fallout keeps coming. We had the situation this week, another $380 million Ponzi scheme just broke. How long can this go on?

Charlie Smith: Well, I think we’re talking sort of about separate issues here. We’re talking about a securities regulatory issue with the SEC, and the ongoing revelations about Ponzi schemes, and that’s simply a failure of enforcement in the area of the Madoff scandal, and the issues with the gentleman down in Houston, who was found to be, I forget the name of his company.

Beth Bershok: Stanford.

Charlie Smith: Stanford, yes. Those issues are simply a matter of lack on enforcement of existing regulations. With regard to the banking system and the need to bailout so many of these large financial institutions in the fall of last year, I think there were too many regulators. There were some regulators, there were certain institutions that were able to shop for the most lenient regulator. For example, AIG was regulated by an entity which was originally designed to regulate and follow small SNLs. So the portfolio and the book of investments in AIG’s portfolio was way over the heads of their regulator. So the regulator was, not only asleep on the job, they didn’t necessarily have the capability of regulating what AIG was up to. So, in that case we didn’t have a proper set of regulations, and we’re reading and hearing that we’re going to try to consolidate some of the regulatory control in the Federal Reserve, I’m not sure if that’s a good idea or not, but I do know the Fed has the expertise to regulate. I’m not sure we want to give them the additional powers. I think we’re talking about two different questions there.

Jim Lange: But what you’re basically saying is, right now there are not sufficient laws on the books to protect investors, and investors then have to do either their own due diligence or hire a money manager.

Charlie Smith: Well, I think with regard to the issues like the Ponzi schemes, those regulations exist.

Jim Lange: Right, I wasn’t even thinking the Ponzi schemes, I was thinking of bank failures and issues that would have an impact on an every day investor, who has a variety of stocks and mutual funds and is trying to stay above water.

Charlie Smith: I think there are some holes in the quilt of regulation, particularly in the area of banking regulation, and the ability of a bank to be over-leveraged. Specific example, we saw institutions like Morgan Stanley and Goldman Sachs and Bear Sterns leveraged 28-30-35 to 1 in the latter part of the financial boom in ‘06 and ‘07. That sort of leverage, almost no matter the environment, is going to blow up at some point, and how is an individual investor going to be able to recognize that sort of leverage when a good portion of it is off the balance sheet. That is, those entities had investments which didn’t show up in the quarterly SEC filings. So, in this case, you didn’t have the ability, if you’re the smartest analyst in the world, and you didn’t get a look at these off balance sheet investments, you wouldn’t have been able to make a good evaluation of some of these banks. So, yes there are some holes in the current regulatory regime that need to be fixed, and we’re hearing, as Beth said, some proposals out there, most of them which concentrate the regulatory power in the Federal Reserve. I’m not, necessarily, in agreement with that, but I think there are some holes that will be filled.

Jim Lange: So, you do have some confidence?

Charlie Smith: Yeah, I think we recognized the problem. I think the question is now, whether we have the political will. And we’re seeing a big push back on the part of the institutions which don’t want to be regulated. The profit seeking entities that are existing on Wall Street certainly don’t want to be regulated.

Beth Bershok: Well, you would expect that.

Charlie Smith: Yeah, and the job of the regulator is to recognize where the holes are, recognize where the problems are, and I think they’ve begun to do that, and put into place the framework that regulates properly, doesn’t over-regulate, and gives the enforcement responsibility to the proper entity, and then sees that those regulations are enforced. That’s where the SEC fell down, as I said, with regard to these Ponzi schemes. We had all the regulatory structure in place to take care of all of those problems, and the laws just weren’t enforced.

Beth Bershok: We are going to take a quick break, Charlie and Jim. We are with Charlie Smith tonight Chief Investment Officer of Fort Pitt Capital Group. It is The Lange Money Hour: Where Smart Money Talks.

4. Is the Recession Over?

Beth Bershok: Thank you for joining us tonight we are talking smart money. I’m Beth Bershok, along with Jim Lange, and our guest tonight, Charlie Smith, Chief Investment Officer of Fort Pitt Capital Group. And we’re discussing the current market environment, and Charlie, I want to toss out a term that has been really in the headlines for the past month, recession, because every time you pick up the business section of the paper, there is conflicting information. Some people think we’re out of it, some people think we’re going to be in it for a while longer, can we talk about that first?

Charlie Smith: Well, let’s think in terms of rate of change in the level of economic growth, because that’s what really defines recession. The recession, the maximum rate of negative change in the economy, probably happened in May or June. So, basically, since the end of May, things have been getting less bad as you’ve seen, I’m sure as described. So, if we’re past the point of maximum rate of negative change, the recession has peaked. It’s not over yet, until the rate of economic growth passes from a negative into a positive, but that may be happening right now.

Beth Bershok: Well, if we’re talking about that, then we need to tie in unemployment, because if people are saying, okay, the recession is over, or we’ve seen the worst of it. How is it possible that unemployment keeps inching up? For instance, the latest number that came out was 9.8%, in August 9.7%.  So, it still is inching up and if we are technically in recovery, or easing out of the recession, how is that continuing to happen?

Charlie Smith: Well, sort of the answer to the quandary there is, the rate of unemployment is a lagging indicator, it tends to lag, the most common measure of GDP growth. So, you can see an economy bottom out and we won’t see the rate of unemployment bottom out for a year, or a year and a half, until after the economy, itself, bottoms out.

Beth Bershok: So, are you saying it could be this time next fall when we start to see numbers pick up?

Charlie Smith: I think we will see job growth. We’re still losing 165,000 jobs a month. I think that was the latest number we got in September, and we will probably see job loss on a month-to-month basis through the end of this year, at least. And, probably, some time in the late first quarter, early second quarter of next year, is my best guess. We’ll start to see new jobs being created, net new jobs created on a monthly basis. Month-to-month, there are hundreds and hundreds of thousands of jobs created and lost. The net numbers that you see is the number that you see, but there’ll be a net positive job number sometime in the early part of next year, is our guess. The big question is, you know we’ve lost from various estimates 7-8 million jobs in the economy since the recession started. You know how long is it going to take all those jobs back to where we have the same level of employment that we had at the end of November 2007, when the job loss really got going? I’ve seen various numbers, it may take until 2012-2013 before we reach those sort of peak levels of employment again. We get the unemployment back down to 5.8%, where it was at the peak of last economic up-cycle.

Beth Bershok: Yeah, a lot of people say it could actually hit double digits before it starts to decline.

Charlie Smith: It wouldn’t surprise me at all, we’re at, what 9.8% now, so it would only take probably three or four more months of 150-200,000 job loss a month, along with continuing increase in the size of the labor force to get us there.

Jim Lange: And perhaps the real numbers are higher because a lot of people have just given up searching for jobs. And that would be of tremendous concern if you are one of the unemployed people hoping to get called back. How big of a concern is that if you are an investor, however? In other words, let’s say since March, if the market is up roughly 50% and employment is worse, maybe if you’re an investor, the unemployment numbers are not such an important indicator for you.

Charlie Smith: Well, I think the problem for the investor comes from the political aspects of unemployment because, believe me, if June of 2010 comes along, and as Beth just mentioned, the unemployment rate is still at 10.1%, or even higher, we will see a concerted effort on the part of the Obama administration to do whatever they can, in terms of pulling policy levers, whether it be another stimulus package, or whatever policy levers they think they need to push to try to get the jobless rate down next year, they’re going to do. From an investor’s perspective,  it really does create additional risk because any time you’re not sure what the policy makers are going to do, that uncertainty creates risk from an investor’s perspective. One of the most fascinating aspects of this entire decline has been the response on the part of corporate America. Corporate America, in terms of the larger S&P type companies, the bigger businesses in this country have responded very, very aggressively to this downturn. And that response has involved basically laying people off. Back in January and February, we were seeing 600-700,000 jobs lost per month in that period. So the response on the part of corporate America to the recession has been very aggressive, and it has provided a very strong boost to profits. Profits in the first half of this year, the first two quarters of the year, came in way ahead of the analyst’s expectations. Now that part of the expectations were set so low, but my point is, that from an investor’s perspective, and a high unemployment rate is a flip side of the aggressive response on the part of corporate America to try to deal with the recession. So, from an investor’s perspective, high unemployment, as you sort of intimated, is not that big issue until it becomes a big enough political problem that the policy response in terms of going into debt, printing money, creates a risk for the investor.

Jim Lange: Well, let me ask you this, a couple times you mentioned kind of the intersection of financial markets and politics.

Charlie Smith: Yes, it’s a dangerous intersection.

Jim Lange: It is, and I’m not going to try to get political, but I have people coming to my office and they say, hey, look, we’re in the middle of two wars. We have the highest deficits we’ve ever had, we’re about to pass some form of very expensive health care, more and more people are going to be on Medicare, social security is just an out of control explosion in terms of the need for money. National security, the risks of terrorism on a number of fronts, nuclear, chemical, all types of things, and they’re saying, how can the market do well in this type of uncertainty? How would you respond to those people whose natural reaction is to go to cash?

Charlie Smith: Right, sure, exactly. Here’s how I frame the entire political-economic collision over the last year or so. When we had the financial collapse in the fall of last year, the response from the Bush administration was to do a couple of things. Number one, create the tarp to basically inject capital into the banking system to be sure that we didn’t see a collapse in the banking system. Next, it was to, on the part of the fed in terms of monetary policy, basically print enough money to make good on a whole lot of debts that people weren’t sure would be good. So the response on the part of the Bush administration really sort of buffered the decline for the financial system and all the people that connected with the financial system. The Obama administration came along a few months later and their response was to come up with a $787 billion stimulus package, the majority of which, so far, has gone to support state and local governments. So, the Bush administration sort of took care of their constituency. The democratic Obama administration has come along and sort of taken care of their long term constituency. A whole lot of local and state in many cases, democratic politicians, but in the middle is the middle class who essentially is being asked to pay for all this. And in a sense, I think a lot of the angst we saw in the summer, with regard to the big issue about health care and the response of the people saying, look, we’re tired of all the bailouts. It’s because so many people in the middle feel like they’ve been left out. And in the end, the only way the markets are going to work is if we get the middle class reengaged. I think that goes to the issue of small business, and a few minutes ago I said that I think large business has responded quite readily to this decline and done the things they need to do. Well, one of the key constituencies, and particularly in regard to job growth, is small and medium sized business, and we really have  not done a whole lot yet for that constituency. Whether it be in terms of policy, and I think we need to do that before we can say, yeah, the markets are going to be completely healthy, because in the end, as I said before, there’s a risk that if we don’t get job growth, there’s going to be a further political response on the part of the policy makers, and we don’t know where that response will take us in terms of higher inflation, more money printing, more debt. So, I think the response, so far, on the part of the private economy and the policy makers, has done some good, but before we can be bullish for the long term, we’re going to need to see small and medium sized business back in the game and engaged and growing again. That’s why we can, sort of, cheer the rally that we’ve seen since March where prices are up 50-55% on the S&P, but we’re not completely sure that we’re going to be able to see good growth a year and a year and a half out. And we’re going to be able to sustain this recovery because we need to see small and medium sized business engaged, and we don’t see that yet.

Beth Bershok: I was just going to ask you that, do you see any signs that that is happening, or any indication there’s going to be some backing for that?

Charlie Smith: In terms of the policy changes, we may need to see a little bit of a change in the congress, and again if we see a 10% unemployment rate in June and July of next year, the swing in congress may be significant. We may see something like we saw in 94 with regard to the Newt Gingrich contract with America and a big swing in congress. And at that point, we may see some further efforts to help small business, but right now, we’re not seeing a whole lot on that front. Again, the efforts on the part of big business is to try to rationalize their business. The efforts on the part of the stimulus package to help state and local governments, those are helping, the efforts on the part of the Fed to try to buffer the decline in the financial system is helping, but we’re not seeing a whole lot in the realm of helping small business yet. We’re going to need to see that before things are going to get better.

5. Rebuilding of Personal Savings

Beth Bershok: And while we’re talking about all of the negative impacts of the recession, there is something that I find really fascinating, which is that in some regards, there has been some success, and one of them has been the rebuilding of personal savings.

Charlie Smith: Yes, exactly. You know in the last part of the big financial boom in 2006 and 2007 the savings rate in this country was almost zero.

Beth Bershok: Which, when you think about that for a second, doesn’t that shock you?

Charlie Smith: Yes, it’s scary. One of the most fascinating aspects of the worldwide economy is the fact that the Chinese, one of the most rapidly growing and dynamic economies in the world, they save upwards of 28-30% of their income. They are massive savers.

Beth Bershok: Did you say 30%?

Charlie Smith: Thirty percent, yes, and that’s because they don’t have the social infrastructure like we do. If you don’t have social security to rely on, if you don’t have the social safety net that we’ve sort of taken for granted in this country, you’re going to save more. So, their society has been very good at building up savings and they, therefore, have become able to invest very aggressively and become low cost producers of just about every single manufacturing good you can name. On the other hand, we’ve been aggressively spending and borrowing. To get equilibrium in the long term in the world economy, we’re going to need to see the savings rate in the US move up, and the savings rate in China move down towards somewhere in equilibrium between those two numbers. We had a zero, or six months or nine months ago, we had zero in the US. Today, its moved up to about 5-6%. That’s a significant increase, and that really is one way you can define the success of a recession. That sounds like an oxymoron, but recessions are all about rebuilding savings, and this recession, so far, we’ve seen one of the most rapid increases in the savings rate we’ve ever seen in the history of the data. So, the fact that we’ve begun to rebuild our savings is very much a positive outcome that we’ve seen so far in this recession. But we’ve got a lot further to go, and as we eventually rebalance the world economy, become greater savers here, and the people in China, in particular, this applies to several developing economies, but in China, in particular, they learn to spend a little bit more then we’ll have a better balance in the world economies. 

Beth Bershok: Do you think this rebuilding of savings is something that’s going to go on long term, or do you think once the economy eventually does turnaround, we’re going to go right back to our 0% saving?

Charlie Smith: That’s a great question, and one of the things that we’re hearing continuously in the media is it’s a new normal. You know people have permanently changed their behavior because they were shocked by the events of the last 12-15 months. I would say, yes, I believe that the spend thrift ways of the baby boomers the events of the past year or so have really brought people up short, and they’ve really thought about where they spend. And the fact that we’ve got so many households that are under water on their mortgages, I think, is sort of forcing that kind of behavior. When you see that there’s 110 million households in this country and about 55-58% of them have mortgages, so we’re looking at maybe 50 million mortgages out there and 10-15 million of them are underwater. That is, the value of the mortgage is more than the value of the house. So, you know that’s a significant number of households out there that are really being forced to take a different financial path because their debt load is just too great, and so they need to change their behavior, and they’re being forced to change their behavior. So, I think we are seeing a permanent change in people’s spending behavior. I think that’s something that we can pretty much count on.

Jim Lange: You mentioned China a couple times, and I have some clients that are very concerned about China. They’re saying, hey, look, they have a $2 trillion surplus as opposed to a deficit. We owe them loads of money, they are building infrastructure, even they are benefitting from the wars that we are waging in Iraq and Afghanistan because if there is some type of stable government created, they’re going to be the trading partners, in effect, taking advantage of all the work and money and things that we’ve done. And, there’s analogies of the United States to Rome and Great Britain fighting wars in far off lands, right before their decline. Do you think that, perhaps, we are potentially a country in decline and that it will eventually be China that will be the top dog, and if so, what kind of impact does that have on today’s investor, and will that change your opinion at all about the viability of long term investments in the stock market?

Charlie Smith: It all depends on Chinese policy. You know in 1988 and 1989, I can remember looking at the cover of Business Week magazine Japan Inc., and how the Japanese were going to own the world. We’re seeing the same sorts of angst about China today, as you just, sort of, brought out. So, there’s no doubt that Chinese economy is growing rapidly. They just passed Germany as the third largest economy in the world. It looks like their economy is going to pass Japan within the next three years. People are estimating that their GDP would pass the US by 2030. I’ve seen new estimates, it might happen by 2025, where they would become the largest economy in the world, but that’s going to depend on policy, that’s going to depend on their leadership. If they allow themselves to get side tracked by an inability to allow people the freedom to speak, for example, you know in a sense, the Chinese leadership has a tiger by the tail. They’ve basically given their society, their people, a chance to experience the benefits of free market capitalism, but they have sort of been very careful about allowing the sorts of constitutional freedoms that we take for granted, that go with that. And I think, unless they are able to, sort of, let that tiger go in a very careful measured manner, it’s going to turn around and bite them. So, in a sense, they’ve got to begin to expand the political freedoms, if they’re going to be able to maintain the economic freedoms that they’ve already begun to build very successfully. So, it’s a question of policy. If they can manage to gradually, basically, seed power over to their people over time, I think we will see the Chinese society surpass ours pretty readily. It doesn’t necessarily have to be a bad thing, as long as we can learn to trade with them equitably.

Jim Lange: I know Jeremy Siegel has a discussion where he says we wants them to succeed because we’re getting old and we’re going to have stocks and bonds, but we need somebody that’s going to make things, and is going to buy our companies.

Charlie Smith: Most certainly. When we saw the Chinese oil company attempt to purchase a big US firm here a couple years back, there was a big political backlash, but believe me, the Chinese, they want to diversify their investment portfolio. Right now, they built a gigantic portfolio of US treasury bonds and mortgage bonds. They want to become owners. As I said, when we first sat down here, you’re going to generate the greatest return for yourself as an investor, as an owner. So, they want to take these reserves that they’ve built from this gigantic trade surplus and invest in, not only in treasury bonds and mortgage bonds, but in businesses and assets around the world. We had better be willing to allow them to begin to invest in, not necessarily the most strategic assets, and we don’t necessarily want them buying titanium plants, or our very most valuable electronics technology, or biological technologies, but basic technologies, basic assets. We should be perfectly willing to sell them to them at a price, and you know the greater freedoms we permit the greater trade. The greater economic relationships we build with, not just the Chinese, but any government around the world, any nation from around the world, the less chance we’re going to end up in conflict with those people.

Beth Bershok: Charlie and Jim, we are going to take a quick break. Our guest, Charlie Smith, Chief Investment Officer of Fort Pitt Capital Group. And, we will be back with more discussion on current market environment. It is The Lange Money Hour: Where Smart Money Talks.

Beth Bershok: We are talking smart money tonight. I’m Beth Bershok, along with Jim Lange and our guest in the studio tonight, Charlie Smith, Chief Investment Officer of Fort Pitt Capital Group. Just a few minutes ago we were discussing a lot of signs of the recession and something that, Charlie, you claim is no longer the big story. Declining home prices for a long time, for months, that has been the huge story, and we even touched on that a few minutes ago, but you claim, now, that the key indicator is actually the rate of increase in bank lending.

6. Increase in Bank Lending

Charlie Smith: Yes exactly. Beginning in late 06, early 07, the focus was, okay, people didn’t believe that house prices could decline, and we found out over the past three years, that most certainly, even a 35-40% decline in the value of your home is a possibility. But that story is behind us now, and the response on the part of policy makers to that decline, and all the fallout from it was to begin to try to print money and get that money into the system to try to re-inflate the system. Well, that response has really not gotten a lot of traction yet because the fed has created a whole bunch of money, and given it to the banks, but the banks have not yet begun to lend it out. It’s only when that money begins to get lent into the system, and it begins to generate economic growth, that we will begin to have a recovery. So, the question is, what variables, what indicators do you need to monitor to know whether this money is starting to be lent out, and the economy is beginning to get traction. So, we’re closely following the velocity of money, which is simply the rate of GDP growth divided by the amount of money in the economy. We’re following the size of the fed’s balance sheet, and we’re just generally trying to make sure that we’re staying on top of the financial variables that let us know when the banks are starting to lend again. It can be as simple as looking at the quarterly reports that the banks file with their regulators about the size of their loan books. The top 20 banks in this country have seen their loan portfolios shrink by about 5-6% over the past 6 months. That’s a pretty simple indicator that the banks are still hoarding cash.

Beth Bershok: What is the explanation for that?

Charlie Smith: Well, the banks aren’t certain what the loss rates are going to be on the loans they already have on the books. That’s the simplest explanation for that. They are uncertain about how severe the losses are going to be on the loans that they’ve already written, and they want to be sure that their rate of earnings and their ability to provide reserves for those loans is good enough. So they’re very careful with whatever cash that comes in the door. They’re not as quick to lend it out as they were four or five years ago because they don’t know just how bad the holes, you know, the Swiss cheese, is in their existing portfolio. There are some segments in the market. The consensus is commercial real estate, for example, is really just in, maybe the third inning of their decline. So there are a lot of concerns out there about just how bad the loss ratios are going to be on these loan portfolios, so the banks are sitting on this cash.

Jim Lange: I have heard you mention this issue of how bad are the toxic assets, if you will, and I know that, even months ago, you were saying that the answer to that question, whatever it is, will help clarify. Do we have any indication yet? I mean, so you were saying this six months ago, do we have any further information that would help us in this?

Charlie Smith: We do. When you were referring, specifically, to the toxic assets, those are connected primarily to mortgage loans, and we’ve learned over the past year or so, particularly now, that house prices have begun to level off after a 35% decline. We’ve learned that most of the mortgage backed securities of good quality are worth somewhere around 55 to 65 cents on the dollar. That’s what we’re finding out. So, that issue of mortgage backed securities in the housing realm is pretty well discounted in prices. What’s a problem now for most of the regional banks, and you know not the top 20 banks necessarily, but the banks from 20-100, maybe is their commercial real estate portfolios, and their commercial loan portfolios. That’s where the uncertainty still remains because a lot of the regional banks, community banks, had built their loan book with real estate loans and commercial real estate loans. So, a lot of the bankers have, sort of, got a handle on how bad their residential mortgage problem is, but they’re not completely certain what the loss rate is going to be on their commercial loan portfolios and their commercial real estate loans, as well.

Jim Lange: Well, I know I was just considering moving our office, and I was surprised at the quality and how much good commercial real estate was available.

Charlie Smith: The numbers just came out today with regard to the price declines in the commercial mortgage backed securities market, and the rates of decline for office rent, for example, around the country, some of the major metro areas, San Diego, year after year, rent is down 10%, New York city is down 12%.

Beth Bershok: Which is stunning for New York City.

Charlie Smith: Exactly. Everybody viewed that as property that would never decline in value, but I guess, as we’ve learned the last five years, you can never say never.

Jim Lange: Well, let me ask you this, traditionally, I think you haven’t been terribly bullish about real estate investments for the long term. Do you think that that might be, and I know that you’re somewhat opportunistic, that is, you like to buy things when they are cheap. Do you think that that might be an opportunity, let’s say, in the next couple years, that when we start seeing some defaults, and we start seeing some problems with commercial real estate, that maybe that might be a little bit more interesting?

Charlie Smith: Commercial real estate is simply another form of equity investing. You can lend against real estate, you can go out and buy a mortgage, but in my case, as another form of equity investment, you know it, obviously, is all about location and price, but in the next three or four years we are going to see a whole lot of properties that were way overloaded with debt during the commercial mortgage boom. That debt’s going to need to be refinanced. You know, I’ve seen various estimates of $500-600 billion commercial mortgages that are going to need to be refinanced that were three and five year loans, that were written between 2006 and 2007, that are going to need to be refinanced and the money’s not going to be there. So, a lot of those properties will go back to the lenders and those lenders will be selling them off, and there’s going to be a terrific opportunity in certain markets in commercial real estate that we’ll see a lot of. We’ve already seen a lot of vulture funds set up to buy that stuff. For example, in Miami, entire condominium buildings have been sold off.

Beth Bershok: That’s an amazing story there in Miami. There is one building where there’s still one resident.

Charlie Smith: In a couple hundred units.

Beth Bershok: It has been very interesting to watch that. We’ve been talking about some of these indicators with the economic recovery. Charlie, are there any other things that the average investor should be looking at?

Charlie Smith: Well, besides the beginnings of growth within the loan portfolios of the banks and the velocity of the money, how the money in the economy is beginning to turn over at a higher rate. As I said before, I think the ability of small business to get their footing and recognize that the end is not near, and we don’t have to lay off your entire staff. I’m not sure where that comes from. If you remember back during the recovery in 2002 and 2003, there were tax cuts, there were aggressive efforts to help small business, and I’ve been reading in the past week or so that the Obama administration is looking at some sort of significant tax credit for hiring.  That may be a wonderful change, but I think we’re going to need to see the classic engine of job growth and economic growth in this economy, small business treated a little bit better and before we’re going to see signs of a real recovery. As I said, the recovery we’ve seen so far is more of a just a rebound from a fear driven collapse and support of the system by the fed and the treasury, and it’s really not an organic sort of risk taking type recovery yet. It may become one, but we’re going to need to get small and medium sized business in the game before we can really say it’s a true recovery.

7. Information Resources for Investors

Jim Lange: Could you tell us a couple resources for readers if they are, let’s say, information hungry and, obviously, there’s all kinds of stuff that you probably don’t think is too credible. What are some of the sources that you think might be good for readers in the investment area?

Charlie Smith: Well, let’s talk specifically about a couple of the indicators I was using. If we want to tell people you know what we think are key indicators, we need to tell them where they can get them. With regard to the velocity of money, with regard to the Fed’s balance sheet, the Federal Reserve, the Federal Reserve’s website is a great place to go. Specifically, the website of the St. Louis Fed. And if you just go to Google and type in St. Louis Federal Reserve, it will direct you right to it. That’s a wonderful source of, sort of, the base line data that will give you an idea of which way the economy is going. With regard to, and the data is unbelievably cheap and unbelievable prevalent, it’s amazing. When I first got in this business in 1983, the data that I use on a day-to-day basis in my business of managing money was costing me $60-70,000 a year. I can get that same information for one-tenth to one-fifteenth of that cost today. So the data is almost free, the information, and you don’t really build value in your investing process by amassing more data or getting it more quickly than someone else. You add value by putting a perspective, having a perspective on the world, and most importantly the ability to keep your head when the world about you is losing its own ability to invest rationally, but in terms of sources of information, you know the Federal Reserve is a wonderful place for basic data about the economy.

Jim Lange: And what about your website, would that be a good source for people?

Charlie Smith: Well, it will give you, sort of, a road map for the basics of investing,. The question you need to ask of someone who you might think about hiring as a financial advisor, that’s something that you’ll find on our website.

Beth Bershok: That’s good advice.

Jim Lange: And what is that website address?

Charlie Smith: It’s Pretty simple.

Beth Bershok: Charlie, thank you for joining us tonight, we really appreciate you taking the time to join us live in the studio. Charlie Smith, who is the chief investment officer of Fort Pitt Capital Group, and again their website is And we have a couple of minutes left. We have Jim coming up in the next month and a half, we have a couple of workshops that we’re going to be presenting, and this is all about a big tax law change that’s coming up January 1st. It’s less than three months away.

Jim Lange: It’s going to be nirvana. We’re talking about tax-free dynasties.

Beth Bershok: You’ve been waiting for this.

Jim Lange: I have, literally for years.

Beth Bershok: For so long, but essentially, what’s happening on January 1st 2010 is that all tax payers will be eligible for Roth IRA conversions and up to this point, there has been an income restriction. So it’s opening up huge on January 1st.

Jim Lange: Up to now, people could not make a Roth IRA conversion if their gross income was more than $100,000.

Beth Bershok: So there are a lot of people who are suddenly going to be eligible for this?

Jim Lange: Right.

Beth Bershok: Okay, so we’re going to be covering this, and we’re also going to be covering a big opportunity for seniors in 2009 to make a Roth IRA conversion and our next workshop and it’s free. This is absolutely free. It’s Saturday, October 24th at the Holiday  Inn on Mosside Boulevard in Monroeville and we have two times, 9:30-11:30 or 1:00-3:00. And I will say this, the last one that we did, which was in August, and we did a bunch of these in the spring, they reach capacity. We have limited seating, so if you would like to attend this, I would make reservations as soon as possible. And you can do that by calling 800-748-1571, 800-748-1571. Tell us which session you would like to go to, the morning or the afternoon. Then we have another one coming up on November 21st, which is a Saturday, as well, and that time we’re going to be back in the Cranberry area at the Four Point Sheraton. Seriously, Jim is so excited about this issue, you have to come and hear this. And we always give a free copy of Jim’s book, the second edition of Retire Secure to every attendee. So again, our next one is October 24th, it’s in Monroeville, 800-748-1571 and you can find out more on our website which is Thanks again to Charlie Smith for joining us, and again, we will be back again in two weeks for another edition of The Lange Money Hour: Where Smart Money Talks.


James Lange, CPA/Attorney

Jim is a nationally-recognized tax, retirement and estate planning attorney with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, will and trust preparation and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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